Banking Run Amok Is Less Likely a Year After Dodd-Frank: View

July 18 (Bloomberg) -- With the first anniversary of the
Dodd-Frank financial reform law on July 21, it’s a good time to
ask: What has it accomplished?

Consumer advocates, many congressional Democrats and some
economists say banks are still too big, the derivatives market
remains untamed and opaque, and regulators have been slow to
write hundreds of rules. The financial industry and Republican
lawmakers, on the other hand, say regulators have gone
overboard, hobbling financial firms with onerous demands,
creating regulatory uncertainty and slowing the economic
recovery.

There are two problems with these views. First, regulators
can’t be moving both too hastily and too cautiously. And second,
such perorations seem to forget that, less than three years ago,
the financial system almost buckled under the weight of
worthless mortgages, and the country narrowly avoided another
Great Depression. Regulators had been blind to the credit boom
and bust; banks took huge risks that exploited regulatory gaps.
Today, the economy remains weak, not because of overzealous
regulators but because of the lingering fallout of the financial
crisis. Fixing all of this will take more than a year, and is
bound to rile financial institutions because, well, it was meant
to.

Dodd-Frank isn’t perfect, but already its influence on the
financial system has been positive, in ways big and small.
Accounting is more transparent; off-balance-sheet assets are
largely a thing of the past. Some banks are selling units that
are too risky, or that require them to hold capital they don’t
have. As Bloomberg News has reported, banks are even hiring
consumer advocates to make sure their policies on overdraft fees
and credit cards will pass muster, now that the new Consumer
Financial Protection Bureau is about to send out examiners.

Getting Tough

Regulators are being tougher, too. We know this because
bank lobbyists are spending a bundle on Capitol Hill, hoping to
rein in the regulators, or at least starve them of the money
they need to perform their new tasks. That is folly. Without
adequate financing, regulators won’t be able to hire the best
and brightest or acquire the technologies necessary to police
the markets.

More big changes are coming, and with them, surely more
complaints from the financial industry. Rules limiting
proprietary trading, the kind that banks do for their own
profit, are in the works. Mortgage application forms will soon
have to be written in plain English, allowing borrowers to more
easily decipher fees and comparison shop. Larger down payments
will be required of most homebuyers. If banks sell their
mortgages to Wall Street, they’ll have to keep 5 percent on
their books, an ever-present reminder not to extend credit to
those who can’t afford to pay it back.

Naming Names

Later this year, a council of federal regulators will
reveal which financial firms will come under special scrutiny
because they are critical cogs in the world financial system.
Some large hedge funds, insurers and asset managers ought to be
in the mix, which by law includes the 35 or 40 largest U.S.
banks, or those with at least $50 billion in assets.

Dodd-Frank won’t fix everything. Regulators are waking up
to the fact that, whatever progress is made in ending the too-big-to-fail mentality, it will stop at the nation’s borders. To
be effective, the so-called living wills that large financial
firms must prepare in case they run into trouble and need to be
shut down should be adopted internationally.

More Is Needed

Rules forcing most derivatives trades to be processed
through clearinghouses, and backed by collateral, should also be
accepted globally to avoid regulatory arbitrage, in which
trading firms move to countries with the least intrusive, and
lowest cost, oversight. Regulators need authority to peer inside
the records of financial firms based in other countries, and not
just the books of their U.S. branches. And the largest, most
globally connected banks should be required to hold more capital
than the 9 percent or so that U.S. officials are contemplating.

With the top 10 U.S. banks holding 77 percent of the
industry’s domestic assets, compared with 55 percent in 2002,
too-big-to-fail is an even bigger worry today. Thomas M. Hoenig,
the Kansas City Federal Reserve president, has said that the
incentives for risk-taking that existed before the crisis all
remain in place. The difference is that, this time, regulators
are on the case -- unless the Dodd-Frank naysayers get their
way.